Making Life Difficult for Your IRA Beneficiary

Because an IRA account owner is trying to keep things simple or just does not get around to changing a beneficiary form, only one person ends up being named on the beneficiary form. The account owner exacts a promise from the beneficiary that he or she will make sure that the account is split between all of the children, or all of the grandchildren, or all of the siblings, or whoever is important to the account owner. The unwitting beneficiary agrees to this since, after all, it is only fair that the account be split.

Now the account owner has died and the beneficiary wants to do the right thing - split the account the way the owner wanted it done. But there is just one problem. The inherited IRA cannot be assigned or gifted from the inheriting beneficiary to the other intended beneficiaries. Every penny the inheriting beneficiary takes out to give to an intended beneficiary is included in the inheriting beneficiary’s income, NOT the income of the intended beneficiary.

You also run up against the gifting rules. The inheriting beneficiary can only gift up to $13,000 (in 2012) to any individual in the year. If he or she gives more than that, he or she has to file a gift tax return.

Naming just one beneficiary may have kept things simple for the account owner, but it creates a nightmare for the inheriting beneficiary. If the account owner truly wants to keep things simple, then he or she should have a beneficiary form that names exactly who should inherit the asset and it should include the exact share they should inherit.

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Herring and Herring v Campbell

John Wayne Hunter passed away in October 2005. He was a participant in a pension plan governed by the Employee Retirement Income Security Act (ERISA). The plan allowed him to designate a primary and secondary beneficiary.

In 1990 and again in 2001, Hunter designated his wife, Joyce Mae Hunter, as primary beneficiary and did not list a secondary beneficiary. After Joyce Mae’s death in 2004, Hunter never designated a new plan beneficiary.

Upon Hunter’s death, without a valid designated beneficiary, the plan provided for the distribution of his benefits to one of five classes in the following order of priority: 1) Hunter’s spouse; 2) Hunter’s children; 3) Hunter’s parents; 4) Hunter’s surviving siblings; 5 ) The administrator of Hunter’s estate.

The plan administrator rejected the possibility that Hunter’s stepsons, Stephen and Michael Herring, might be entitled to their stepfather’s benefits. Since Hunter’s spouse had predeceased him and he had no surviving parents and no biological or legally adopted children, the plan administrator distributed the benefits to Hunter’s six siblings.

Two years later, the stepsons challenged the decision under the Texas probate law doctrine of “equitable adoption.” A district court agreed with the Herrings, but the U.S. Court of Appeals reversed its decision, determining that the plan administrator used a legally correct definition of “children” to determine who was entitled to the benefits.

LESSON TO LEARN:
It’s actually really simple. If Hunter wanted to make sure his stepsons received his ERISA plan benefits, he should have named them as beneficiaries on the plan documents. He left it open to interpretation, and the plan administrator ruled accordingly.